Summary

Auto suppliers often impose non-price restrictions, such as territorial restrictions and customer restrictions, on their distributors. In previous penalty decisions of Anti-Monopoly Enforcement Authorities (“AMEAs”), non-price restrictions in association with resale price maintenance may be found violating Article 14(1) or (2) of the Anti-Monopoly Law (“AML”). However, AMEAs have yet punished any standalone non-price restriction under Article 14(3) of the AML.

On March 23rd, 2016, the NDRC issued the Antitrust Guidelines for Automotive Industry (Consultation Draft) (“Consultation Draft”) to solicit public comments. The Consultation Draft, for the first time, provides explicit guidance for those non-price restrictions which auto suppliers often impose on their distributors from competition law perspectives. In this regard, vertical non-price restrictions in automotive industry are likely to become the new focus of the AMEAs’ enforcement.

This article mainly discusses the non-pricing restrictions in distribution of new automobiles and analyses relevant provisions in the Consultation Draft. Regarding vertical restrictions in automotive aftermarket, please see our series article Highlights-Introduction of the Antitrust Guidelines for Automotive Industry– Antitrust Issues in Automotive Aftermarket.

Regulatory approach on vertical non-price restrictions: presumed exemption and individual exemption

As provided in the AML, a basic framework to regulate monopoly agreements is “Prohibition plus Exemption” method. [1] As a catch-all clause, Article 14(3) of the AML provides that any other monopoly agreements (other than resale price maintenance) recognized by the AMEAs shall be prohibited. Article 15 of the AML then allows companies to argue that their business practice shall be exempted from prohibition if they can prove that such practice falls in one of specific situations provided in Article 15, will not severely restrict competition in the relevant market, and will allow consumers to benefit from the interest arising therefrom.

To reduce the costs of legal enforcement and to provide certain safety areas for companies, the Consultation Draft provides that under certain circumstances Article 15 could be presumed to apply. Presumed exemptions are only applicable to companies who do not have significant market power. The Consultation Draft provides that companies with a market share below 25%-30% are normally not having significant market power.

Territorial restrictions and customer restrictions

Pursuant to the Consultation Draft, territorial restrictions refer to restrictions that suppliers shall only supply to certain distributor(s) within certain territory and the distributor shall not supply outside such territory. Customer restrictions refer to restrictions imposed on distributors by suppliers that preventing them from supplying to a certain group of customers or exclusively assigning them to a group of customers.

  • The Consultation Draft’s attitudes towards territorial restrictions and customer restrictions:

In the last version of the Consultation Draft for internal discussion, it was clearly provided that territorial restrictions and customer restrictions that significantly eliminate or restrict competition may be decided as “other monopoly agreements” set forth in Article 14 of the AML. Although foresaid provision has been removed from the present version, territorial restrictions and customer restrictions that significantly eliminate or restrict competition, as we understand, may constitute violation of the AML.

However, some territorial restrictions and customer restrictions can improve distribution efficiency. For instance, in the distribution of new automobiles, where distributors need to carry out investment for brand protection and maintenance, territorial restriction could usually boost efficiency and would not significantly eliminate or restrict competition. Thus, The Consultation Draft explicitly provides that the following territorial restrictions and customer restrictions are generally presumed exemptible:

  1. Restricting distributors to only supply in their business premises, while such restrictions do not apply to passive sales or cross-selling among distributors;
  2. Restricting active sales to certain territory or certain group of customers exclusively allocated to another distributor by the supplier; or
  3. Restricting direct sales by wholesalers to end users.

At the same time, the Consultation Draft provides that exemption shall not be directly applied to the following territorial restrictions and customer restrictions since they normally substantially restrict the competition and induce increase of price as well as decrease of customers’ choices.

  1. Restricting passive sales by distributors; or
  2. Restricting cross-selling among distributors.

It is noteworthy that the last version of the Consultation Draft for internal discussion distinguished distributors between authorized and unauthorized. In an authorized distribution system, auto suppliers without significant market power are generally permitted to require authorized distributors not to supply to non-authorized ones. However, the present version of the Consultation Draft does not make such distinction between authorized and unauthorized distributors any more. Based on a literal comprehensive reading of the current Consultation Draft, we understand that even auto suppliers without significant market power shall not restrict authorized distributors’ supplying of automobiles to unauthorized distributors.

  • Passive sales

For the first time, the Consultation Draft makes a distinction between passive sales and active sales. According to the Consultation Draft, passive sales refer to those sales which distributors are engaged due to the request of individual customer rather than their own initiative marketing. For example, purchase made in territory B by customer from territory A constitutes a passive sale of distributors in territory B.

The Consultation Draft further provides that the following circumstances in e-commerce shall be regarded as passive sales:

  1. A customer browses the websites of the distributor or of a third-party, and makes contacts with the distributor consequently; or
  2. A distributor sends information to unspecified customers through its own or third-party websites, and the customers contact the distributors voluntarily.

We notice that the abovementioned provisions regarding active sales and passive sales in the Consultation Draft are very similar to those set forth in the Block Exemption Regulation on Vertical Restraints issued by EU Commission[2]. In addition, although The Consultation Draft only applies to automotive industry, the provisions on passive sales may be a reference for vertical agreements in other industries.

Other vertical restraints on sales of new automobiles

The Consultation Draft points out that the following vertical restraints imposed by auto suppliers through agreements or business policy may also improperly restrict the sales ability of distributors. If such restraints significantly eliminate or restrict competition, raise the resale price, or impair interests of consumers, relevant agreements and business policy may be decided as vertical monopoly agreements subject to the AML.

  1. Tie-in sales of automobiles, aftermarket spare parts, accessories, consumables, repair tools, detecting instruments and others by auto suppliers to distributors.
  • The Consultation Draft makes it clear that tie-in sales implemented by suppliers to distributors can also be assessed as vertical restraints, which may lead to an exclusive purchasing obligation upon tied goods.
  1. Auto suppliers force distributors to accept unreasonable sales targets, quantities and varieties of inventory.
  • The Consultation Draft allows auto suppliers and distributors to reach agreements on reasonable sales targets through fair negotiations. However, unilateral conducts by suppliers which force distributors to accept unreasonable sales targets, quantities and varieties of inventory, may lead to an exclusive purchasing obligation of contract products upon distributors.
  1. Auto suppliers mandatorily require distributors to cover the cost of promotion in the name of the suppliers, including advertisements and auto shows, or force distributors to advertise in certain ways and media at their own expense.
  • The Consultation Draft points out that suppliers and distributors are allowed to promote and market the products jointly and share the costs on a reasonable basis. Meanwhile, to ensure the overall effect of the promotion, auto suppliers may set up reasonable quality standards for media selection. However, if costs of promotion demanded by the auto supplier are imposed to distributors on mandatory basis, arrangements may be assessed as vertical restraints. Such restraints may be regarded as violation of Article 14 of the AML if they restrict the capacity of promoting and marketing of distributors and increase costs of distribution indirectly.
  1. Auto suppliers require distributors to engage specific paid designers or builders, or use specific brand, suppliers or supply channels of building materials, general equipment, information system and office facilities they need.
  • The Consultation Draft points out that, auto suppliers may set up quality standards for distributors regarding design, decoration and office facilities of the business premise in order to maintain the brand image. However, if restriction of the brand, suppliers and supply channels is not necessary for brand maintenance, such restraint may improperly restrict the competition of relevant market and increase costs of distribution, thus be regarded as violation of Article 14 of the AML.

It should be noted that the abovementioned behaviors are originally only explicitly regulated under Article 17 of the AML (abuse of dominance). For the first time, the Consultation Draft makes it clear that such restrictions imposed by suppliers may be regarded as vertical restraints and violation of Article 14 of the AML, if they eliminate or restrict competition. Nevertheless, under the circumstances that auto suppliers do not have any market power, we understand that such non-pricing restraints on distributors would be less likely to have the effect of eliminating or restricting competitions.

Moreover, the Consultation Draft also requires that auto suppliers shall clearly list the reasons for refusal to supply or terminate distribution agreements if they decide to do so. This rule is designed to prevent auto suppliers from refusing to supply or terminating agreements without any justifications but only because of pro-competitive conducts of distributors, such as refusing to implement the minimum resale price set by the suppliers and purchasing original spare parts from channels other than the suppliers.

Conclusion and suggestions

The Consultation Draft provides more detailed rules for conduct and analytical approaches regarding vertical non-price restraints in automotive industry. Vertical non-price restraints in automotive industry may become a new focus of the AMEAs as the Consultation Draft coming into force.

The Consultation Draft may also have influence to the current business models of auto suppliers and distributors. The Consultation Draft specifically points out where similar vertical agreements are adopted by most or even all companies in the relevant market to form a network with comprehensive coverage, the cumulative effects thereof may restrict the competition in the relevant market. Thus, when making assessment to the business models, auto suppliers and distributors shall also take the cumulative effects into consideration.

Furthermore, although the Consultation Draft will only be applied to the automotive industry, some of its analytical approaches may shed some light on other industries. Therefore, we recommend companies in other industries to monitor the legal enforcements in this area closely.